Ross5eChap14sm - Chapter 14 : Corporate Financing Decisions...

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Chapter 14 : Corporate Financing Decisions and Efficient Capital Markets 14.1 a. Firms should accept financing proposals with positive net present values (NPVs). b. Firms can create valuable financing opportunities in three ways: Fool investors. A firm can issue a complex security to receive more than the fair market value. Financial managers attempt to package securities to receive the greatest value. Reduce costs or increase subsidies. A firm can package securities to reduce taxes. Such a security will increase the value of the firm. In addition, financing techniques involve many costs, such as accountants, lawyers, and investment bankers. Packaging securities in a way to reduce these costs will also increase the value of the firm. Create a new security . A previously unsatisfied investor may pay extra for a specialized security catering to his or her needs. Corporations gain from developing unique securities by issuing these securities at premium prices. 14.2 In an efficient market, the cumulative abnormal return (CAR) for Prospectors would rise substantially at the announcement of a new discovery. The CAR falls slightly on any day when no discovery is announced. There is a small positive probability that there will be a discovery on any given day. If there is no discovery on a particular day, the price should fall slightly because the good event did not occur. The substantial price increases on the rare days of discovery should balance the small declines on the other days, leaving CARs that are horizontal over time. 14.3 You should not agree with your broker. The performance ratings of the small manufacturing firms were published and became public information. Prices should adjust immediately to the information, thus preventing future abnormal returns. 14.4 a. Ansari’s stock price should rise immediately after the announcement of the positive news. b. Only scenario (2) indicates market efficiency. In that case, the price of the stock rises immediately to the level that reflects the new information, eliminating all possibility of abnormal returns. In the other two scenarios, there are periods of time during which an investor could trade on the information and earn abnormal returns. 14.5 Under the semi–strong form of market efficiency, the stock price should stay the same. The accounting system changes are publicly available information. Investors would identify no changes in either the firm’s current or its future cash flows. Thus, the stock price will not change after the announcement of increased earnings. 14.6 False. The stock price would have adjusted before the founder’s death only if investors had perfect forecasting ability. The 12.5 percent increase in the stock price after the founder’s death indicates that either the market did not anticipate the death or that the market had anticipated it imperfectly. However, the market reacted immediately to the new information, implying efficiency. It is interesting that the stock price rose after the announcement of the founder’s death.
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Ross5eChap14sm - Chapter 14 : Corporate Financing Decisions...

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